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All American Pipeline Essay

2454 words - 10 pages

ALL-AMERICAN PIPELINE CASE WRITE-UP

EXECUTIVE SUMMARY
The business nature of the project—pipelines—affected many of our assumptions and approaches to our calculations for our ultimate decision. The case provided two sets of cost estimates from an outside consultant and from Goodyear after hiring a general contractor. We utilized both sets of costs that directed us to the same decision that Goodyear should not go ahead with the Pipeline Project.
Once we obtained the UFCF, the terminal value was calculated in three different ways, treating the pipeline as an asset on our books, finding the value of project if cash flows are received for perpetuity an finding the annuity value of cash ...view middle of the document...

This was again supported by the significantly lower IRR of the project, 13% as compared to the WACC. We made projections and calculations using estimates of Goodyear’s contractors as well as did a sensitivity test using the data of outside consultants, and the negative NPVs of both the projects showed that Goodyear should not go ahead with the project.

ASSUMPTIONS
Working Capital:
• In the CF statement given, no separate values for working capital accounts are given so the calculations are done assuming working capital to be 0.
Contingency:
• We disregarded contingency. We did not treat it as a cash component of working capital or as a capitalized expense because it was unclear in the case if the contingency was ever spent.
Growth:
• We assume that the revenues from pipelines grow at the rate of inflation which is 5%, after reaching capacity.
Tax credit:
• We assume that Goodyear benefits from tax credits from this project and therefore the benefit is added to the cash flows.
For calculating terminal value:
Using the Asset Method
• The Depreciable PPE calculated for North American Pipeline was sum of total cap ex in 1985 and 1986 excluding the land and right of way, contingency fund. 50% of Investment tax credit was not subtracted from the value of depreciable PPE because it does not affect the value of assets. This is unlike the calculation done for tax purpose, as shown in Exhibit 8.
• As mentioned in the case, PPE is depreciated on a straight line method for 30 years, for calculating the remaining asset worth.
• Value of land is added to the remaining asset worth to calculate the terminal value.
Using the Perpetuity Method
• For calculating the terminal value using perpetuity method, the growth rate used has been 5%, which is equal to the inflation rate. This assumption has been based on the fact that after reaching capacity production the increase in revenue and expenses will be based on the inflation rate.
Assumptions for Consultants’ estimates
• We have assumed that the capital expenditure, estimated by the consultants is invested evenly over two years in terms of 1983 dollars.
• Land and right of way cost the same as given in estimates of the contractors.
• Operating expenses have been assumed to be 145.3 million annually in 1983 dollars and have been adjusted by inflation rate of 5% from 1985 onwards.
• For tax purposes, depreciation schedule is used to be the same as that provided by the contractors
• Investment tax credit in this case is assumed to be the same as contractors’ figures, as the Depreciable PPE is almost the same in both cases.

QUESTIONS
2. What is the WACC? (We did this question first to get the WACC we need in order to use the perpetuity method in finding the terminal value in question 1.)
To find WACC, we used the following equation:
WACC = (1 – t * (D/V)) * rU
To find Celeron’s beta of debt, we assume that Goodyear has a bond rating of Baa. Therefore, rD of Celeron, a company owned...

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